Privatisation and Market Imperfection

Today I’m posting a link to my Singapore friend and colleague, Eddie Lee. The story behind this link is a strange one – almost surreal – and more or less directly related to my ‘friendster’ post last Saturday. I met Eddie back in February while I was Googling the net looking for some material to blog. I was looking for something on the Italian economy, and I found a link to an article in Singapore’s Straits Times, which, apart from touching on Italy, seemed also to talk about my favourite topic – ageing – to boot. Now I have the unfortunate habit of scan-reading a lot of material quickly, and as I scanned I found an argument I really liked. I’m going to post this I thought to myself.

So I did a quick cut and paste into my blog. And it was only then, after pasting, while trying to think of some cutting comment to make, that my eye was struck by something I hadn’t expected: my own name. You see Eddie had been rumaging about in my website, and I must now publicly give him the credit (or is it the notoriety) for being the first journalist I know of to have taken my demography argument seriously. Well cutting a long story short, I subsequently contacted him, to begin what I hope will prove to be a long and fruitful relationship. Going back to the substance of my Saturday post: I now know a lot about Eddie, his wife’s name, his childrens names, that he went – like I did – to the LSE (10 years after me), that he used to work for the central bank in Spore etc etc. The one thing I have no idea of is what Eddie looks like. I can only imagine.

I like the piece I am posting today because it questions received wisdom: the point is that received wisdom, when it becomes unthinking dogma is dangerous. Argentina is a living proof of this. Of course, in many cases deregulation and privatisation can be enormously beneficial. But if the process is applied unthinkingly, or if it is simply the transfer of a state monopoly to a private one, then it is much more problematic. It goes without saying that a regulation ridden and corrupt public sector alternative is no alternative at all. However, as Eddie says, markets do fail, and not only occasionally. This seems to be the most misunderstood part of the story.

Privatisation can harm the public good By Eddie Lee

LAST week, the re-nationalised owner of the British railway system, Network Rail, announced that it would cancel private sector contracts for the maintenance of its 32,000km network. The decision followed a series of fatal train crashes, which spurred concern that safety standards were being overlooked in the company’s rush for profits. From breakdowns of railways to power blackouts such as those that happened in the United States, there’s a rethink worldwide on how best to deliver public services. In the United Kingdom, the performance of rail companies has deteriorated, with 20 per cent of trains running late and passenger complaints up by 8 per cent over the past year. Ironically, the big companies were the worst performers: South West Trains notched up a 275 per cent increase in delays, measured in total passenger time, last year. And despite the dismal service record, some train fares were raised by more than twice the rate of inflation earlier this year.

The British rail privatisation experience is significant because it was symbolic of the many privatisations first championed by then prime minister Margaret Thatcher. A number of public services which were earlier thought to be ‘natural monopolies’ were privatised and subjected to market forces, in the belief that this would result in lower prices and improved service.But so far, not many people think that has happened.

Here’s Britain’s story.

British Rail was sold in 1996 with the following plan: passenger trains were to be run by 25 Train Operating Companies on franchises, while the railway signalling, tracks, bridges and stations were to be handled by a private company – Railtrack. But Railtrack went bust because attempts to raise profitability backfired. Reductions in expenditure on maintenance and repair led to an increase in accidents and delays that proved costly as the company was fined by the Rail Regulator and also had to compensate train operators for each delayed train.

Investigations into the fatal Hatfield train crash on Oct 17, 2000, and into two other rail accidents revealed that the number of Railtrack workers had fallen by over 60,000 from 159,000 in 1992, even though the number of trains had increased. Railtrack went bankrupt last year, and was replaced with the government-controlled Network Rail. And it looks as though the London Underground could take a step back from privatisation as well. There are inklings that maintenance work may be moved slowly away from the private sector.

As for the subway operators, British transport expert Professor John Whitelegg notes that they now get more public subsidy, about 1.5 billion pounds (S$4.4 billion) a year, than British Rail got in its last few years of existence. Mr Richard Bowker, chairman of the Strategic Rail Authority, is worried about the growing financial frailty of some of the operators and aims to dramatically reduce the number of companies to a handful. What has happened in Britain is that private interest (trying to maximise company profits) ended up with a huge social cost (not just higher fares and delays, but also fatal accidents due to negligence).

In Singapore, Acting Health Minister Khaw Boon Wan expressed his concern over such a divergence of private and social interests when he rebuked hospitals recently for engaging in ‘silly competition’, and urged hospitals to save money for patients, rather than make more profits for themselves. The belief that public interest is best served by liberating enterprise from state intervention has shaped thinking for almost two decades. The California Energy Crisis of 2001 was one of the first rude awakenings. But even though economists have pointed out that the crisis was actually caused by the manipulation of market power, people still cling to the belief that deregulation reduces market power.

Last month, a report by the United Nations’ Conference on Trade and Development asked whether market-led reforms adopted in many developing countries after the debt crisis of the early 1980s have strengthened the ability of these countries to withstand external shocks. The disappointment is deepest in Latin America, which ironically is where deregulation has gone furthest. But after initial success, privatisation has roused anger. Take the case of Argentina’s privatisation of water and sanitation in 1993: Sewerage infrastructure development has not kept pace with water delivery expansion, due in part to the fact that water delivery is twice as profitable as sewage treatment. As a result, over 95 per cent of Buenos Aires’ sewage continues to be dumped into the Rio del Plata.

So how to avert unnecessary crises from misguided privatisation projects? Professor Paul Krugman of the University of Princeton suggests critical analysis in place of blind faith in the market. This is especially so in the case of companies that also need to respond to shareholders’ short-term interests. Markets do fail, and sometimes they fail spectacularly to provide for the public good. Unless private and social interests can be adequately matched, it’s silly to sweep all problems under the carpet of competition. Transport Minister Yeo Cheow Tong says the Government’s suggestion last week that SBS Transit could transfer the loss-making North-East Line to SMRT was a rethink, not a U-turn. Whatever it is, there’s no shame in admitting a good decision. The next question is, should the problem be left solely to the market to resolve?
Source: Straits Times

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

52 thoughts on “Privatisation and Market Imperfection

  1. “consequences often so widespread that the government will be forced to intervene in the resulting chaos anyway”

    Good point Elliott, this is the often neglected ‘moral hazard’ argument.

  2. Elliott,

    “You have to place privatisation processes within this larger context.”

    We are on a convergence course. One potential outcome of privatisation is the consequences for income distribution although other factors are simultaneously influencing that as well. In Britain, we have this:

    “The gap between rich and poor in Britain is at its largest in 13 years and poverty levels under Tony Blair exceed those under Margaret Thatcher, government statistics reveal. Figures from the Office for National Statistics for income inequality show that differences in disposable, post-tax income at the top and bottom of society have returned to levels last seen in 1990. The report shows that the ‘Gini coefficient’, an international measure of inequality, has increased from an average of 29 points under Baroness Thatcher to 35 points under Mr Blair. The figure for 2001-02 was 36 points. The gap between rich and poor, which was relatively static in the early Tory years, soared in the late 1980s and then declined slightly through the early 1990s. It began an upward trend in 1995 and continued to rise under Labour, which came to power in 1997. . .”

    – from:

    As well as that, there are what might be termed mixed blessings. Someone mentioned earlier the shrunk margin of spare capacity in electricity generation in the Netherlands. That has happened in Britain too.

    As I recall, c. 1990 we had then a margin of approaching 25% on top of the capacity needed to meet peak demand, a wastefully large safety margin, whereas in the news now there is talk of how we need to focus on putting down more generating capacity to cope with winter peaks as aged coal-fired and nuclear power stations are phased out. In fact, the early news had it that the margin is now so tight we need to worry about secure supplies this winter but that seems to have been just a scare.

    What has happened, of course, is that privatisation led to competition between electricity generators, which also became concerned about achieving and maintaining returns to capital employed comparable with other investments of broadly equivalent risk. Problems like that didn’t arise pre-privatisation because there was a state-owned monopoly supplier which could charge consumers whatever was needed to cover the interest charges on the capital locked up in the margin of idle generating capacity.

    There are several potential solutions for ensuring an “adequate” safety margin, each with its own cost tag which consumers will ultimately have to pay. What I suspect is rather muddling a decision on resolving the problem here is that for different reasons both coal-fired and nuclear stations are politically sensitive issues so the government is pondering the handling. Personally, I think there is much to be said for putting in and retaining nuclear capacity to meet base demand because running costs of nuclear are relatively low, in comparison with other fuels, and running nuclear will not contribute to greenhouse gases but that is highly controversial in Britain. France gets just over 70% its electricity from nuclear and we even buy supplies at peak times from them but they don’t seem to be afflicted with the likes of our anti-nuclear crowd.

    There are potential side-effects from all privatisations, each with its own narrative. In 1982, Amersham International was the very first of Mrs Thatcher’s privatisations. It now specialises in medical electronics and has very recently been acquired by General Electric in America, the largest global company by market valuation in the Business Week Global 1000 in 2003: I thought that take over of a privatised British company by an American multinational might have stirred up some controversy but – very sensibly – there was barely a ripple in the reporting media.

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